How Are Callable Bonds Risky?

If you own a callable bond, chances are that it will be called at the worst moment — just as interest rates are falling and the value of your bond is on the rise. At that moment, the company that issued the bond, if it has the right to issue a call, no doubt will.

And why not? Interest rates have fallen. The firm can pay you off and find someone else to borrow money from at a lower rate. Because calls aren’t fun, callable bonds must pay higher rates of interest.

If you’re inclined to go for that extra juice that comes with a callable bond, then you should always do so with the assumption that your callable bond will be called. With that in mind, ask the broker to tell you how much (after taking his markup into consideration) your yield will be between today and the call date.

Consider that a worst-case-yield. (It is often referred to as yield-to-worst-call, sometimes abbreviated YTW.) Consider it the yield you’ll get. And compare that to the yield you’ll be getting on other comparable bonds. If you choose the callable bond and it winds up not being called, hey, that’s gravy.

Some squirrelly bond brokers, to encourage you to place your order to buy, will assure you that a certain callable bond is unlikely to be called. They may be right in some cases, but you should never bank on such promises.

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